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How Volatility in Emerging Markets Could Dent Big U.S. Stocks

What do McDonald's, Coca-Cola, Philip Morris and PepsiCo have in common aside (ahem) from being champions for good health? All have sizable emerging markets exposure, an asset class that has roiled world equities this year, with expectations of more volatility to come.

NEW YORK (The Street) -- What do McDonald's (MCD), Coca-Cola (KO), Philip Morris (PM) and PepsiCo (PEP) have in common aside (ahem) from being champions for good health? All have sizable emerging markets exposure, an asset class that has roiled world equities this year, with expectations of more volatility to come.

Fund managers cautioned investors to be aware of this risk, even if they do not advocate a selloff of vulnerable stocks.

Wells Fargo Funds Management chief equity strategist John Manley pointed to consumer staples as an exposed sector. "Emerging markets are viewed as the largest part of the growth potential for these stocks," he said in a phone interview. "It's a risk, but it's not enormous."

Manley also pointed to the exposure of large U.S. banks, noting they tend to place larger bets in emerging markets amid a slower growth trajectory for developed nations.

Citigroup (C) this week received subpoenas from the Federal Deposit Insurance Corp. and U.S. prosecutors after disclosing allegedly fraudulent billing at its Mexico arm that cost it up to $400 million. The bank also has investments in Ukraine and Russia, with around $10.3 billion in net exposure to Russia, the highest among major U.S. banks, according to analysis from Royal Bank of Canada.

The energy sector has large multinational exposure, with Chevron (CVX) this week being forced to boost its staff security in Ukraine's shale fields. Royal Dutch Shell (RDS.A) and Exxon Mobil (XOM) drill for oil and gas in Russia while Siemens (SI) had plans to build rail infrastructure in Ukraine.

In the tech sector, Russia's largest search engine operator is listed on the Nasdaq. Yandex (YNDX) shed more than 14% on Monday as tensions with the Ukraine heightened and has since regained more than 7%. But daily volatility is perhaps of little concern to its investors given the stock has rocketed 42.5% over the past year, a lesson in placing stock fundamentals above macroeconomic moves.

The increase in earnings volatility for widely held defensive names like Procter & Gamble (PG) and Colgate-Palmolive (CL) is also likely to lead to a de-rating for these stocks, Macquarie's global head of research John O'Connell warned clients.

"U.S. and European stocks with high emerging market exposure are likely to underperform as they face the double whammy of slower growth and negative currency effects," he said.

O'Connell suggested that select global luxury brand names would also be crimped by slower spending growth and foreign exchange risks from emerging markets. "The group had performed strongly since 2008, but is unlikely to surprise on the upside given the corruption crackdown in China. Key names include LVMH, Hermes and Prada," he said.

Despite the risks, Manley does not advocate selling stocks on the basis of emerging market exposure alone. "We'll see some volatility but I ask whether there's a reasonable chance of selling and buying (these) stocks back at a better price, and the answer's 'no'," he said.